Investing in real estate with cash? Why you might want to reconsider

Published: Friday, Aug. 2, 2013 11:50 a.m. CST

Home prices are finally starting to rise, but not so much or so quickly that the great deals are disappearing. In fact, right now many investors have moved back into the market buying up properties that they will either rehabilitate and resell or rent out for cash flow. With interest rates still incredibly low, it’s easy to make a profit on the spread between your monthly mortgage payment and the rent you can get for the home.

But this means you have to get a home loan, which probably means you’ll be working with a bank. Right now, banks are not enjoying a very good relationship with most consumers, and there’s a lot of distrust in the marketplace — some of it justified and some of it not. It’s also true that banks would rather lend money for owner-occupied homes than investment homes, because there is less risk involved in these deals. That can make it harder to get the money you need from a lender.

Consequently, some folks are making the decision to just use their own money to invest in real estate. While this sounds like a good solution on the surface, there are a number of reasons why it is not.

OPM

First, the best investors try to never use their own money. You’ve probably heard the acronym OPM, which stands for Other People’s Money. That’s not a joke. Putting your own capital at risk, especially if you don’t have more than you need, is not generally wise if you have another option.

Time value of money

The second reason you never want to tie up your own money in an investment if you have other options has to do with a term called time value of money. You see, money isn’t really worth what you think it’s worth for very long.

Time value of money is a central concept in finance theory, and it’s used to figure out what money will be worth at some future time, given interest earned or inflation during that period. It has to do with buying power, and it basically says that the dollar you hold today will buy less in the future.

By tying up your own money in an investment property, you’re basically loaning it to yourself at 0 percent interest. Every year that money sits there, tied up in the home, it can actually buy you less of a different asset that might pay you interest and create a growing balance.

Value over time

But what about the house? Isn’t that the real investment, and won’t it grow in value every year? That’s what a lot of people thought before the housing crash. At best, the investment you make in an investment property today will return cash flow during the life of the investment, which will be offset in part by mortgage payments you make on the property and additional costs for repairs and maintenance to keep the home rentable.

It’s not a bad investment, but not one you’re likely to want to put your own money into, not if you have an opportunity to build a relationship with a mortgage lender — especially at today’s rates.